Make a Profit AFTER Paying Yourself

The biggest mistake I’ve made as an entrepreneur? Confusing my role as an investor with my role as the general manager.

As an investor, my role is to infuse money into a project or a company. Then I kick back and wait for the returns.

As the general manager, my role is to oversee the daily grind. I send emails, make phone calls, conduct research, source supplies, and do a hundred other tasks that amount to the nuts-and-bolts of the daily drudgery.

In many entrepreneurial ventures, it’s common to wear many hats — to be both the investor and the employee. In doing so, it’s easy to confuse “profit” with “paycheck.”

You Don’t Work For the Stocks You Own

If I bought stock in Coca-Cola, I wouldn’t be expected to renovate the Coke bottling factory, drive to the delive

ry warehouse when an order gets shipped, or design the next Coke commercial. As an investor, that’s not my job. My job is to raise the capital, accept the risk, and collect the return.

If I designed the next Coke commercial or drove to the warehouse to oversee shipping, I’d demand to be paid for my work, regardless of whether or not I also invest in the company.

Why should running your own business be any different?

Recently, I’ve come to realize that within my real estate activities, I’ve been confusing my role as an investor with my job as the project manager. Many real estate investors – including me – think we can make a “bigger return” by doing the work ourselves. That’s means we’re performing hours of tasks, valuing that labor at $0, and then proclaiming, “Hey look, I just made a 10 percent return!”

Newsflash: that’s not “making a return.” That’s taking on a second job (often a poorly-paying one).

Pay Yourself

As a business owner, my role is to say, “I need to hire someone at $X/hr, and their tasks will be …”

But I shouldn’t confuse my paycheck with my profit. Those are distinct payments, made for distinct contributions.

I’ve been making that mistake within my real estate investing projects. My recent decision to start delegating work, rather than doing everything myself, brought that reality to light. When you HAVE to put a monetary value on labor costs, the true profit margins come into sharp focus.

Profit vs. Paycheck

In that post, I described how small business owners often confuse “making a profit” with “earning a living.” I illustrate this with a hypothetical scenario about a freelance writer named Sally:

Sally subtracts [her expenses] from her income of $55,000, and reasons that her business made a pre-tax profit of $44,608. Right? Wrong. $44,608 isn’t the profit her business made … it’s simply money left over to pay herself a salary.

Let’s imagine Sally had an assistant who earned $25,000 a year doing research for Sally’s stories. Sally would deduct that research assistant’s pay as an “expense” before calculating her profits, right? So why doesn’t she value her own time?

In other words: I can’t value my time at $0, value someone else’s time at a rate that’s greater than $0, and make an apples-to-apples comparison between the two.

When I wrote that post, one reader left a comment saying:

“… the IRS says that profit after expenses (net profit) *IS* the owner’s income/salary. So in a sense, it is profit – from an IRS standpoint.”

Yep, that’s part of the problem. Our tax code reinforces the idea that your time is worth $0 if you do-it-yourself.

Don’t take business lessons from the IRS.

Your Biz Might Not Be Profitable YET – And That’s Okay

That being said, very few businesses are profitable in their first few years — and that’s okay! This website “makes a profit” in comparison to the money that I’ve invested into the hosting and design. But this website is wildly unprofitable in comparison to the cost of hiring someone to write content and manage the marketing.

I’ve created a job, no doubt about it. But after I pay the writer a fair wage, there’s no profit left over.

And that’s okay, because the website is only one year old, and I don’t expect it to make a profit (after paying the writer’s fees) within the first year. Heck, I don’t expect a profit in year two, either. Year three, maybe. Let’s hope.

The bottom line? No matter what business you’re running – whether you’re a blogger, house-flipper, freelance writer, cookie baker or puppy day care owner – remember that your goal is to make a profit AFTER paying all the employees, including yourself.

Comments

I agree. This also allows the “business” (aka you as the CEO) to understand what money it has leftover to invest. If you’re taking all the profit home as profit and then investing, you’re most likely either doing your own or the business’s bank account a disservice. Value your own time, and those lines become less blurry.

@femmefrugality – Exactly. If the business can’t tell the difference between the CEO’s pay (you) and the businesses’ own internal money, then functionally, the CEO is inseparable from the business — which means it’s not a sustainable enterprise. Like you said, things run much more smoothly when those lines are clarified.

Many businesses aren’t really profitable *unless* the owner works in them for free. That’s called a “job” and while being self-employed is arguably better than working for someone else, it’s still a job.

There’s a big difference between working “in” your business and working “on” your business.

This is one of the common themes with investors and can be seen on shows like Shark Tank and Dragon’s Den.
“My company made 75K last year.”
“Is that after you paid yourself a salary?”
“No.”
“So, you didn’t really make anything last year. As an investor, I won’t see any return.”

This is great – it seems so obvious after you explain it but I would argue to say that many self-employed people and company owners make the same misjudgment. And yes, your work should not be considered free or without value just because you opted to venture out and start your own business. Entrepreneurship can be scary, risky, and highly rewarding – not to mention incredibly necessary in our society! Kudos to you for doing what you love and realizing that doesn’t have to mean your time isn’t worthy pay!

I used to ask business owners “are you working for your business or is your business working for you?” Most admitted they worked for their business. Turning around your system so you pay every employee (including you) is step one to identifying the reality of how the business can really work for your benefit.

I think a lot of people aren’t business owners as much as they are self employed. However, it’s often necessary to go through the stage of being self employed to get to the stage of being a business owner. If you’re going to own a business, you need to know what works. You also need to be the visionary. I’ve never thought of it before, but I need to take time to evaluate the work I do as an employee in my business as if I was an entrepreneur evaluating the performance of a regular employee, i.e., one that’s not me. If I did that, would I be happy with my work?

@Shawanda – Oh, I agree, that stage absolutely necessary! It’s tough as nails to create a job, and its even harder to create a leftover profit AFTER paying out that job. And I like your idea of evaluating your own performance as an employee … would I promote myself? Or would I put myself on probation?

The tax codes. Why don’t they recognize that small business owners must earn an income out of the profits? I think this is why I don’t really distinguish between income and profits as much as I should, but you are right — we should always pay ourselves first.

Paula, Thought provoking. I have to really force myself to hire out for anything because I like to be a “do it yourselfer” in just about everything. Give me a few more hours in the day, and maybe it would work.

@Barb — I have to force myself to delegate, too … it doesn’t come naturally for me. But I’m convinced that delegation is the best way to manage work/life. Your own time is limited; your ability to manage other people’s time is unlimited.

That’s enlightening! My husband and I are paid $0 in our new business and we get a very little ROI. We have recently launched a t-shirt printing business(screen & digital). Every time I calculated the price quotations, I never included ourselves which I now understand to be totally wrong.

Okay, so my next target is how to balance production cost, labor fee(including us) and product price.

@Belinda — Good for you for starting to think about how much your own time is worth! Sometimes, especially when you’re first launching a business, it’s hard to earn enough money to pay yourself. The margins can be slim at the beginning. If you earn $0 for a few months or years — that’s okay! — as long as your ultimate goal is to make a profit after paying yourself a fair wage. Best of luck!

Great points here. Love the integration of the tax code into the pay yourself first approach. Another way I have heard it said is that any job that you can hire someone to do for less per hour than your time is worth makes economic sense.

In other words if you make $55k and can hire an assistant for $22k to do all the work you do now you’ve effectively made $33k more then you did before because you freed up all the time you previously used to make the $55k yourself. You can now go make another $55k in something else.

Very interesting, but can you explain more on how this works on tax forms? Is this idea just a thought to see if you made a profit or an actual expense that you can file on your tax returns?

If it’s an actual expense we can file on tax returns, do we have to write ourselves paychecks on a weekly/monthly basis as proof to IRS? Does that mean we have to file separate tax returns – one for personal and one for business? If we pay ourselves in cash, isn’t it easy to make up numbers to say we make no profit so that we don’t pay taxes on the business?